Question 1: Using IS/LM, AD has models of the economy, show that monetary policy is effective in the short run but neutral in the long-term.
Monetary policies include activities undertaken by the central bank to regulate the supply of money in the economy, and adjust economic activities and future growth. In application monetary policies govern the access to finances for production and purchasing capital goods, investment in real estate, and elevating the use of technology, innovation, and improving economic performance (Jha, Ghosh, and Ghosh, 2016). The use of monetary policies help govern economic performance and maintain growth by predicting changes in economic variables and application of supply and demand forces to create positive economic performance and outcome. In addition to increased production activities, monetary policies have different implications on the short term and the long-term economic performance.
Assuming that the IS-Curve represents the demand for money while the LM-curve represents the money supply, in the short run, increased supply of money causes the LM curve to shift to the right. The increased money supply in the economy leads to reduced interest rates (from i1 to i2) as consumers can access finances at different financial institutions (Kriesler and Nevile, 2016). These effects lower the equilibrium point and increase organizational productivity as well as the industry performance hence increasing yield from Y1 to Y2. The increased supply of money leads to reduced interest rates which further leads to increased investment activities targeted to capitalize on the access of cheap capital. Another effect of the increased money supply in the short run is the increasing exportation of goods as well as demand for raw materials and other products which sparkle and improved economic performance. On the other hand, reduced money supply shifts the LM curve to the left, reduces productivity and economic performance, and increases product prices.
The IS-LM Model
y1 y2 Y
In the long run, the increased money supply results in increased productivity and industrial yield from Y1 to Y2. Eventually, the increased productivity force firms to raise prices to make higher profits from the booming economic activities. The continued rise of product prices forces the LM curve to shift to the left while forcing the equilibrium point to regain its neutral position and move from point 2 back to point 1. In the long run, the productivity yield also returns to the neutral point from Y2 to Y1 hence the assumptions that the monetary policy can be used to influence economic performance in the short run, but its effects remain neutral over the long term.
Question 2: Identify condition under which you would recommend activist monetary policy. Use resources if you need.
Monetary policies are most applicable in solving short-term economic challenges and variables for instances in cases of price stabilization, maintaining interest rates at affordable prices, and promoting increased economic performance and investment (Chortareas and Mavrodimitrakis, 2016). Cases such as inflation and increased production costs can be addressed by allowing the producers to access finances at reduced interest rates, increasing investment attractiveness by lowering the interest rates and allowing the exploitation of production resources, for instance, labor and capital which are rewarded hence improvement of production and individual living standards. Monetary policies can also be adopted in cases of stagnated economy by helping improve access to capital and the rate of employment, promoting innovation and development in technology (Tcherneva, 2014). However, for the long-term objectives, the government must incorporate the fiscal policies with the monetary policies to establish structural growth and persistent economic growth.
Chortareas, G., & Mavrodimitrakis, C. (2016). Can monetary policy fully stabilize pure demand shocks in a monetary union with a fiscal leader?. Economic Modelling, 54, 463-468.
Jha, S., Ghosh, A., & Ghosh, C. (2016). Interaction between the Real Sector and the Financial Sector: An Alternative to the IS-LM Model. Contemporary Issues and Ideas in Social Sciences, 7.
Kriesler, P., & Nevile, J. W. (2016). IS-LM and macroeconomics after Keynes. In Post-Keynesian Essays from Down Under Volume I: Essays on Keynes, Harrod and Kalecki (pp. 69-80). Palgrave Macmillan UK.
Tcherneva, P. R. (2014). Reorienting fiscal policy: A bottom-up approach. Journal of Post Keynesian Economics, 37(1), 43-66.